Jud shares insight into some of the benefits in the
recent drop in energy prices and how new efficiencies and opportunities have
been created for service providers in the sector. His thought-provoking commentary
provides a unique perspective and paints a more positive outcome for the
relationship between energy and water for the future.

Jud, with
your background in water and energy, you have insight into how boom and bust in
the energy sector has impacted the opportunity for service providers in the
water treatment business. First of all, can you tell us how the boom created
such a high profile concern over water usage and treatment and how that built
the opportunity?

A: Jud Hill,
Managing Partner, Blue Star Capital, LLC.

The
hydraulic fracturing for deep strata hydrocarbons (2 miles deep) has been
around for many years. It has only been
in the last 5 to 7 years it has it gained dominance. Some 60 to 70 percent of
the wells completed today are hydraulically fractured. Ironically, it is still
referred to as unconventional horizontal drilling. A couple of points that are
important to note about the relative usage of water in hydraulic fracturing.
First - understanding the entire water value chain which considers the
following: sourcing of fresh water, transporting or “provisioning” the water to
the drilling pad, storing the water on-site in preparation for a frac, managing
the return water coming back out of the well, post frac. This return water is
referred to as flow-back, which is the water that comes back over 4 to 6 weeks
post frac, followed by produced water which will last as long as the life of
the well (twenty plus years potentially). The flow back and produced water then
needs to be transported (by truck or pipeline) to an offsite location to be
disposed of or recycled for reuse. Disposal is typically via a salt water
disposal well (SWD) and recycle, albeit discussed at length, is a very small
part of this water value chain…at least for the time being.

Each step of
this value chain has a different price point depending on which shale formation
you are operating in. For example, in
Texas (Permian and the Eagle Ford) where water is in short supply, fresh water
is more expensive than disposal. In Pennsylvania (Marcellus) where water is
prevalent, fresh water is much cheaper than transportation and disposal. Most
importantly, the largest variable in this value chain pricing spectrum, almost
independent of the shale formation, is the logistics or transportation costs.
This is best demonstrated in Central Pennsylvania where SWD’s are currently
illegal. The transportation costs can be as high as $15/bbl to haul the water
to eastern Ohio to a permitted SWD. It is surprising that many of the
Exploration and Production companies (E&P’s) don’t appreciate or manage the
“all in” cost of water. There is a saying in the frac water business that the
service provider that reduces the “windshield time” or hauling distance will
win the customers’ business. In essence, frac water service is a logistics not
a technology business.

Q:
Investorideas.com

As the public
and government reacted to the sector, new regulations and rules also came into
play. How did that impact the sector on both sides, from the energy companies
to the service providers treating the water?

A: Jud Hill,
Managing Partner, Blue Star Capital, LLC.

Public
awareness and regulation are always important drivers in the water sector. The
frequently unsaid reality is that industry doesn’t mind strong regulation. They
want predictability (set a standard and don’t change it frequently) and
consistently enforce the standards. A high regulatory bar keeps out the bad
actors and on balance doesn’t affect the all in price of crude oil that much.
Generally speaking, most of the experienced and well capitalized E&P
players strive to be good stewards of the water supply and want to be seen as
green/sustainable actors. The brand damage that comes from doing it wrong is
far greater than the perceived savings of a few cents per barrel by trying to
cut corners. Of course, treatment companies embrace strong regulation.
Regulation is one of the under-pinning’s of ensuring that water is priced as a
valued commodity and not a “free good” as some like to think.

Q:
Investorideas.comWhat are
some of the myths and misperceptions out there on the relationship with energy
and water?

A: Jud Hill,
Managing Partner, Blue Star Capital, LLC.

As
mentioned in my previous answer and as crass as it may sound, behaviors are primarily
driven by the pricing of the commodity, be it energy or water. Most folks know
what they pay to heat and light their homes but many don’t know how much they
pay for water. It is still very cheap. Furthermore, guess what the primary cost
is in the pricing of water? - The cost of energy to move the water thru a
pipeline.

Not a myth
but a reality. More than 20% of California’s energy is used to move water
around the state.

We all seem
to know how much a gallon of gasoline cost at the pump…why? - Because it has a
big impact on our disposable income. How much is a gallon of water that you
draw from the faucet? - Less than a
penny.

Water and
energy are inextricably tied. We now label it as the water/energy nexus.

Another misconception
or unappreciated fact is that energy has many substitutes (e.g. oil, coal,
nuclear, wind and solar). Water has
ZERO. The best example of perfect price inelasticity… without water, you will
die (a need not a want) and, if need be, you will pay any price for it.

Q:
Investorideas.com

You
recently told me in a phone interview how the recent drop in energy prices has
created a new era of efficiency in the sector and how that has created an even
better opportunity for the service providers. Can you run us through the cycle
and where things stand today?

A: Jud Hill,
Managing Partner, Blue Star Capital, LLC.

The water
value chain I described previously has changed dramatically at $50 WTI

Three
things are occurring:

E&P drillers are
shifting from exploratory drilling that allows them to “drill to hold”
acreage which are new regions of a shale formation that are not well
defined in terms of yield…at $100 bbl it can justify the risk…to what is
referred to as “infield drilling” or drilling between proven wells where
they own the reserves. This concentrates the water volumes into a smaller
geographic area.

The Moore’s law of
fracking is at work….drillers are getting more efficient and better at
drilling tighter frac patterns which translates to more wells per pad (3
or 5 moving to 10 to 15) causing a conservative increase of the amount of
water used and produced by a factor of say three.

And lastly, drillers
are shifting from a “gel frac” formulation to what is called a “slick
frac” approach. Gel fracs require about 75,000 bbls of water per frac
where slick fracs require twice the amount of water - up to around 150,000
bbls per frac - a 2x multiplier for water.

So, assume
the cumulative effect of these three drivers and you have dramatically changed
the water value chain…increasing the water volumes in a smaller area of
geography. Now it makes more economic sense to build a “hub and spoke”
collection and treatment system. The spokes are a buried network of salt water
gathering pipes (dramatically reducing the need for trucks…reducing windshield
time…remember?) Everybody wins…the environment, road infrastructure, safety,
public acceptance, greener and at around $2/bbl to transport the water, the
E&P’s save lots of money. The hub is an SWD and potentially a recycling
system to return clean salt water back to the drilling area with a sister
return pipeline laid next to the collection pipe. Same set of savings apply to
recycling by reducing the amount of fresh water required for the next set of
fracs.

Q: Investorideas.comIn closing
, with analysts on both sides seeing energy prices going higher and lower in
the year ahead, where do you see it headed and if prices rise will the new
efficiencies in place be lost moving forward? Do you think the industry has
learned to manage resources better and will hold on to that lesson?

A: Jud Hill,
Managing Partner, Blue Star Capital, LLC.

I am not
smart enough to predict where the price of oil is going, but as long as we
price water as a valued resource - everybody will win.

Bio:

Mr. Hill
recently reestablished his management advisory firm with sector verticals to
include energy, water environmental services, general industrial and life
sciences. Particular expertise in the nexus between energy, water and
agriculture. Advisory services range from M&A, capital structures
(equity/mezz. and senior debt), and operations advisory including business
strategies, markets and personnel optimization.

Has over 30
years of experience in both water and environmental service company operations
as well as over a decade of private equity experience in the water
industry.

Prior
experience includes serving as a Managing Director of NGP Energy Capital
Management where he led the firm's efforts in sourcing, execution and
monitoring of opportunities in the water and oil field services sectors. Prior to NGP, Mr.Hill was a Managing Partner
with Summit Global Management, Inc. where he was responsible for all private
equity investments in the water sector. From 1999 to 2008, he served as a Managing
Director of Aqua International Partners and then The Halifax Group, both
affiliates of the Texas Pacific Group. Mr. Hill’s early career was with
Atlantic Richfield and Westinghouse Electric Corporation where he held
operating and executive roles in the environmental and water sectors.

Mr. Hill
received a Bachelor of Science in Biology/Chemistry in 1977 from Edinboro State
University and a Bachelor and Masters of Science in Environmental Engineering
in 1979 from the University of Pittsburgh. He serves as a Trustee of the Water
Keeper Alliance.

Currently
serves on the Board Of Directors for Abtech Industries, Inc. and Greenstone
Resource Holdings. Formerly served on the Board of Directors for Meineke Auto
Care Centers, Soil safe Inc., North American Video Inc., Biotronic Systems
Corp. and Westinghouse Bioanalytic Systems Corp.

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